How Does a Business Appraisal Work?
A business appraisal is an assessment that identifies a company’s market worth. Many business owners need this information when planning a sale, buying a business, or handling legal or tax matters. When valuing a business, business appraisers use several different methods to ensure an accurate valuation. If you have ever asked yourself, “How does a business appraisal work?” this guide walks you through the process. We explain each step of a business appraisal so you know what to expect.
Peak Business Valuation is a trusted business appraiser. We value over one thousand businesses across the United States each year. If you are seeking a business valuation, contact Peak! Schedule a free consultation today to get started.
What is a Business Appraisal?
To answer the question, “How does a business appraisal work?” you must first understand what a business appraisal is. A business appraisal is a process that determines a company’s fair market value. It reflects what the business is worth today based on its financial data and industry trends. Business owners can use a business appraisal to gain a clear picture of their company’s value and make informed business decisions.
In the following sections, we examine Peak Business Valuation’s five-step business valuation process. If you have any questions, contact Peak today to schedule a free consultation!
1. Identify the Purpose of the Business Appraisal
Valuing a business begins with an initial meeting between the business owner and appraiser. The valuation expert determines the purpose of the valuation and gathers information to identify the applicable methods. Understanding the owner’s needs ensures the business valuation is accurate and specialized. Below, we discuss common situations when a business appraisal is needed:
- Buying a Business or Selling a Business: A business appraisal determines a company’s worth before a sale or purchase. Sellers can rely on it to set a fair asking price and buyers use it in negotiation. It also builds trust on both sides by providing clear, objective numbers.
- Partnership Changes: When a partner joins or exits the business, a business valuation ensures that ownership shares are fairly priced. This reduces conflict between partners and provides a documented value for future reference.
- Divorce & Litigation: Courts often require a business valuation when dividing assets between parties. The valuation report provides objective numbers that hold up in formal settings and help resolve disputes faster and smoother.
- Estate Tax Planning & Succession Planning: A business valuation helps owners plan for the future transfer of the business. It supports estate tax planning, gives heirs a clear understanding of the company’s value, and helps guide a smooth transition.
- Applying for Financing: Lenders often require a valuation to assess the business’s financial strength and identify collateral value. A business appraisal also builds trust with lenders by presenting objective data.
There are many scenarios when a professional business appraisal is essential. Check out When to Hire a Business Appraiser for more insight.
2. Analyze the Data
After determining the purpose of the business appraisal, valuation experts begin their analysis. They first review the financial statements, factors like cash flow, profit margins, and revenue trends from previous years. After examining company financials, business appraisers conduct market and industry research and adjust for the company’s risks and growth potential. Each of these elements contributes to a credible business valuation.
When evaluating a business’s fair market value, business appraisers consider key value drivers. Value drivers are unique factors that increase or decrease the company’s market value. Some common value drivers that business appraisers look for when valuing a business include:
- Revenue & Profit Margins: Strong and steady financial performance increases business value. Buyers and investors look for consistent growth because it signals lower risk. Declining or unstable trends can reduce value.
- Quality of Management: A skilled leadership team promotes stability and simplifies ownership transitions. Moreover, strong managers improve operations, employee performance, and long-term planning. Weak management can decrease buyer confidence and thus lower value.
- Customer Base: A diverse and loyal customer base reduces dependence on key clients. This variety ensures more diverse and stable earnings. Heavy reliance on one customer usually increases risk and lowers business value.
- Growth Potential: Buyers want businesses with room to expand. Clear growth opportunities, such as new markets, products, or technologies, increase a company’s value. Limited growth potential often makes the business a riskier investment.
- Assets & Equipment: Well-maintained, modern assets support efficient long-term operations. Outdated or poorly maintained assets lower the value and add future expenses.
The value of each business is influenced by unique value drivers. To learn more about your company’s value drivers, reach out to Peak Business Valuation! You can also check out Factors That Affect a Valuation Multiple for more examples.
3. Prepare & Conduct the Business Valuation
The third step to answering “How does a business appraisal work?” is to determine the business’s fair market value. Business appraisers follow a structured process to calculate this figure. After reviewing the company’s financials and studying the market, they apply standardized valuation approaches. Most business appraisals rely on three core techniques that assess value from a different angle. This comprehensive process helps produce a well-rounded fair market value estimate. We break down each valuation approach below:
- Market Approach: The market approach compares the business to similar companies that have recently sold. It generally involves reviewing market data, sales multiples, and industry benchmarks. This technique provides insight into what buyers are currently willing to pay for comparable businesses.
- Income Approach: This approach measures value based on the company’s future earnings. Valuation experts study past performance and forecast expected cash flow. They then apply a discount rate to calculate the present value of those earnings to determine fair market value. This approach also takes into account risks of the business.
- Asset Approach: The asset approach estimates value by determining the fair market value of assets and subtracting liabilities. This technique is common for asset-heavy companies or businesses with unstable earnings.
Valuing a business often requires more than one valuation approach. Valuation experts compare the results and weigh each method according to the situation, type of business, and available data. This results in a fair, well-supported final conclusion of value.
4. Finalize Results
The fourth step is to finalize the results of the valuation. Once the valuation expert has conducted research and determined the company’s fair market value, they deliver the results to the client in a business valuation report. This report outlines the research, findings, strengths, weaknesses, fair market value, and methods used during the business appraisal. The business appraiser also discusses the document with the client. They answer questions and provide key information related to the business valuation. Buyers, sellers, and investors can rely on the valuation report to guide important business decisions.
5. Connect with Professionals
After completing the business appraisal, Peak Business Valuation helps business owners determine their next steps. We can make introductions between our clients and trusted advisors. No matter the purpose of your business valuation, we ensure you get the help you need.
Conclusion
Peak Business Valuation follows five general steps when valuing a business. To answer “how does a business appraisal work,” these five steps follow as first, a meeting between the business owner and appraiser to determine the purpose of the valuation. Second, valuation experts analyze the company’s financial and industry data. Third, they conduct the business valuation by applying proven methods. Fourth, finalizing the results in a business valuation report, and fifth, Peak Business Valuation can connect business owners with advisors and other professionals. Schedule a free consultation with Peak today to get started!
